Good afternoon everyone and welcome to AXT's first quarter 2018 financial conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer and Gary Fischer, Chief Financial Officer. My name is Sarah and I will be your coordinator today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this call is being recorded. I would now like to turn the call over to Leslie Green, Investor Relations for AXT. Ma'am, you may begin.

Thank you Sarah and good afternoon everyone. Before we begin, I would like to remind you that during the course of this conference call, including comments made in response to your questions, we will provide projections or make other forward-looking statements regarding, among other things, the future financial performance of the company and our ability to control costs, improve efficiency, increase orders in succeeding quarters, increase our competitive position in the market, our schedule and timeliness regarding the relocation plan, our thoughts on air pollution in Beijing, our ability to meet demands for our products, as well as other market conditions and trends including expected growth in the markets we serve. We wish to caution you that such statements deal with future events, are based on management's current expectations and are subject to risks and uncertainties that could cause actual events or results to differ materially. These uncertainties and risks include, but are not limited to, overall conditions in the market in which we serve, global financial conditions and uncertainties, increased environmental regulations in China, market acceptance and demand for the company's products and the impact of delays by our customers on the timing of sales of products. In addition to the factors that may be discussed in this call, we refer you to the company's periodic reports filed with the Securities and Exchange Commission and available online via link from our website for additional information on risk factors that could cause actual results to differ materially from our current expectations. This conference call will be available on our website at axt.com through April 25, 2019. Also, before we begin, I want to note that shortly following the close of the market today, we issued a press release reporting financial results for the first quarter of 2018. This information is available on the Investor Relations portion of our website at axt.com. I would now like to turn the call over to Gary Fischer for a review of our first quarter results. Gary?

Thank you Leslie. Good afternoon. Total revenue for the first quarter of 2018 was $24.4. This compares with $26.3 million in the fourth quarter of 2017 and $20.6 million for the first quarter of 2017. As we announced on April 11, the shortfall to our guidance given on February 21 was a result of government ordered mandatory factory shutdowns in Beijing, caused by severe air pollution that occurred late in the quarter. In spite of this, the year-on-year comparison shows growth of 18% in Q1 of 2018 over Q1 in 2017. Our total revenue substrate sales were $19.4 million, compared with $20.5 million in the prior quarter. Revenue from our raw material joint ventures was $5.1 million in Q1 compared with $5.8 million in Q4 2017. In the first quarter of 2018, revenue from North America was 8%, Asia Pacific was 66% and Europe was 26%. Two customers generated more than 10% of revenue in Q1 and the top five customers generated approximately 38% of total revenue, reflecting again our diversification of both products and customers. Gross margin in the first quarter was 39.2% compared with 37.2% in the prior quarter. Total operating expenses were $5.6 million in the first quarter of 2018 compared with $6.1 million in the fourth quarter. Total stock compensation expense for the first quarter of 2018 was $466,000. Operating profit in the first quarter of 2018 was $3.9 million, compared with $3.7 million in the previous quarter and $1.4 million for the Q1 of 2017. Interest and other income for the first quarter was a net charge of $407,000. This net number consists of four categories. One, net interest earned of $142,000. Two, equity accounting on our unconsolidated joint venture companies of a loss of $334,000. Thirdly, foreign exchange loss of $224,000. And fourthly, other…

Thank you Gary and good afternoon everybody. The disruption of our Q1 revenue from mandatory pollution related factory shutdowns was disappointing. As we indicated in our April 11 release, these shutdowns between February 27 to March 31 affected more than 300 manufacturing companies, which were intermittently shut down for a total of 10 days or 30% of the calendar days in this period. Periodic shutdowns are not uncommon, but the concentration of shutdowns at the end of the quarter was unusual. To help mitigate the issue going forward, we are adjusting our operating procedures to build more units to forecast rather than building to order. There is no Chinese New Year holidays in China in Q2, so we are getting off to a good start. We are also adding capacity to indium phosphide and gallium arsenide to allow us more flexibility to ramp production as needed. And finally, we are working closely with the local government in Beijing and appreciate their responsiveness. Despite the shortfall in revenue, Q1 was a positive quarter in many aspects. We continue to see positive demand for our products. In addition, favorable product mix and good manufacturing yields combined for increased gross margins. We also completed the first phase of facilitization of our Beijing facility, installed wafer processing equipment and produced initial wafers that can be used for qualification. In total, AXT continues to execute to our plans supported by a healthy market environment and solid customer relationships. We continue to be encouraged about the opportunities across our product line as well as our readiness to participating in it. Now let's begin with indium phosphide. We posted solid revenue in the first quarter, though he was down slightly from the prior quarter as the shutdown affected our sales in every substrate categories. As we mentioned…

Thank you Morris. As we discussed, we are encouraged to see upside potential across our portfolio and believe we are positioned well in many applications that will drive our business growth in 2018 and beyond. As such, we expect to see revenue in Q2 of between $25.5 million and $26.5 million. We believe our profit per share in Q2 will be in the range of $0.07 to $0.09 based on 40.364 million diluted common shares outstanding. This concludes our prepared comments. Morris and I will be glad to answer your questions now. Operator?

[Operator Instructions]. Our first question comes from Edwin Mok with Needham & Co. Your line is now open.

Okay. Great. Thanks guys. Thanks for taking my questions. First, I guess just talking about directionally, it looks like you are guiding up a little bit and you said that indium phosphide has got flattish to up. So most of growth, we should expect come from GaAs, it sounds like. Did I get that correctly? Or is that something I am missing?

Well I think we said indium phosphide, we should see some growth. GaAs will have some gross as well and also germanium.

I see. So basically across the board you see some modest growth then. Okay. On the first quarter, you guys reported very strong gross margin. How much of that comes from just stronger raw material pricing and baked into the guidance you assume margins at a similar level or at least in the high-30s? Is that correct?

Well, there is a couple of reasons that the gross margin was as good as it was. One is that indium phosphide was pretty good for Q1. And the weight that it had on the overall performance in terms of revenue was higher than normal because the other product lines dropped more than indium phosphide dropped, in terms of not making the original guidance and plan. So that's the product mix and the richness of indium phosphide is one element for the upside. And the second, it is in the raw materials business and the refined gallium companies which should improve margins and also in the pBN company, but not in the raw gallium company which is just an external.

Yes. Gary, let me remind you also, in the germanium business, we used to lose a lot of money because of that joint venture and the germanium price has increased quite a bit. So I think instead of losing a lot of money, we are losing less money germanium. So that also helped there.

So based on your guidance, am I correct, we should assume high-30s in gross margin then?

Well, what we had said all along is, we want to see some consistency north of 35% level before we felt it was safe to nod to being above 35%. And I am okay to past 35%. I don't know if I want to say high-30s, but maybe halfway in between, I think, is reasonable.

Okay. That's fair. On the Dingxing facility, maybe just kind of look beyond, you guys already shipped your first wafer, as you suggest, with scrape harvester. Just maybe if you can give us rough a roadmap of kind of what should we expect the progress there? How much capacity you expect you to have to move by, I don't know, let's say, second of this year or not this year, 2019? Just kind of give us a roadmap in terms of how we think about that capacity ramp more, not this month, but in the longer term. Thank you.

The Dingxing facility that we build out and we facilitized, which we announced, is certainly the first phase. We will have a second phase be completed some time the middle of July. And we have a third trench which is almost doubling what we have, which we will build almost equivalent of the capacity that we have in Beijing to be finished by the end of the year. So it's going to be continued building as well as the facilitization as well as you know getting qualified for future production for gallium arsenide in Dingxing facility.

I see. So by the end of the year you should have similar capacity in Dingxing that you can basically increase your process if you need to all your process there?

Yes.

I see. Okay. That's helpful color there. That should give us some yardstick to think about. Last question I have, there was a ban kind of issued by U.S. government on selling products to ZTE in China. Does that have any impact on your business?

So far we have seen not a direct impact on us. We have seen some market indication that may affect some of our customers. But we have not seen any direct impact on us so far.

I see. You don't sell it directly to ZTE. You may sell it to your customer and then that may impact you. I see. Okay. Thanks for clarifying. I just wanted to make sure. That's all I have. Thank you.

Thanks Edwin. Next question.

[Operator Instructions]. Our next question comes from Richard Shannon with Craig-Hallum. Your line is now open.

Hi Morris and Gary. Thanks for taking my questions. Let's see here. Maybe I want to ask a question, make sure I heard your prepared remarks right today. I hear you say that you are expecting some relative weakness in your raw materials revenues in the second quarter. And I think you described some struggles there. Can you describe what exactly is going there?

Sure. Yes. We were talking specifically about one of our joint ventures. That joint venture was producing gallium and traditionally has been the large contributor for our revenue for joint ventures. But because of the prolonged low gallium price, that has produced some problems seen both in terms of organization as well as cutting costs. So we are sort of uncomfortable. And we have seen the revenue coming down in first quarter already and so we are taking the project of continued revenue growth for this particular joint venture. So that's why we are taking the expected revenue down from this joint venture. That affected our overall revenue perspective for Q2 as well.

So is it a revenue issue? Because it doesn't sound like it can be a pricing. So is it a revenue issue?

No. It's not a revenue issue per se. But as I said, the gallium price has been down for almost by like three or four years. So this company has been losing money for quite a while. So we have a, should I say, organization issue with the company that requires a lot of attention and needs to install new management structure and hopefully that we can ride this ship so that it can deliver good revenue growth again.

Okay. Fair enough. Maybe I will take the topic offline here. Thanks for that. A question on silicon photonics. It sounds like you could see a little bit of softness in the second quarter but you see some good long-term opportunities here. Maybe you can talk about the breadth of customer base? I think your revenues are driven at least from an end customer point of view, largely by a single guy out there. Are you seeing a broadening of that customer base? And if so, can you describe where you are seeing that?

Actually Richard, I think we have more than one customer in silica photonics. I think the dynamics is such that, as you know, back in 2017 and even in 2016, our PONs business was really weak. So we were really very appreciative of the very rapid growth of the silica photonics business. And in fact, we were expecting it to continue to grow into this year. But then it late last year and early this year, we start to see some softness in this business, but we were hoping that they can correct itself. But what we are doing the market check, preparing for the guidance for the second quarter, we start see maybe they had more inventory to rebalance themselves. So at least for Q2, we are going to have a problem selling into this particular account. And actually, this plus our second account is not very, very robust either on data center silica photonics. But on the other hand, we do read from the industry analysis in saying data center is continue to grow and they will go to higher speed, 400G which really fits very well for overall silica photonics as well as indium phosphide. That's why we have the high hope for it to come back. But for this second quarter guidance, we are taking a conservative view, because I think, it will have a rebalancing of inventory issue.

Okay. Fair enough. Maybe a couple more questions from me. One to maybe follow-up on a prior question regarding 3-D sensing and your expected qualification process. Do you have any communication channels to the end customer about their sense of urgency, to use your words, of bringing on you as a supplier at some point during the product cycle here later this year?

We always communicate with our customers. But I don't know which one you are talking about. But then, we are working closely with our end customers and with the new facility opening up, we are very hopeful that they will take a favorable view of our capability as well as capacity going forward. But I really think, for this particular customer, I think maybe we are guessing who you are guessing about, it's probably more of a 2019 event rather than 2018. But as we said in our prepared comments, we are having many, many, well not many, many but quite a few other customers which are serving the 3-D sensing applications. They are in development stage and we are seeing a steady increase in revenue for the last few quarters now. So we are hopeful it's not going to be a single customer event. But I know that all investors are eyeing on this one particular customer, but we think this is not a big issue. I think there are many, many opportunities for us. But we are not giving up on this large customer opportunity either.

Okay. Fair enough. One last question from me. I think you said you had two 10% customers in the quarter. I know you typically don't identify those on the calls. Can you give a sense of what the product here they are involved with, gallium arsenide, indium phosphide there?

One is gallium arsenide and the other is indium phosphide, yes.

Okay. I can probably guess who those are. That's all the questions for me guys. Thank you.

Thank you Richard.

Thank you. Our next question comes from Gus Richard with Northland. Your line is now open.

Yes. Thanks for taking my question. Could you just give a little color on what you are seeing in the LED market? Is that continuing to be strong? Or how do you see that playing out right now?

I think the LED market is pretty healthy. As we said, we had a good customer that was telling us that they continue to see growth in the area in automotive applications. And so we are seeing, they are telling us that they probably will see double-digit growth for the rest of the year. I mean they are giving us a six months order, which is higher than what we expected. They are also telling us they are expanding their capacity. They took us for a tour for their new factory expansion which is very impressive. So we think that LED is going to see continued growth.

And is the Euro versus the dollar having any impact on that customer? Or should I go ask them?

No. So far we have always dealt with them based on dollars.

Okay. All right. Thank you so much.

Thank you.

Our next question comes from Hamed Khorsand with BWS Financial. Your line is now open.

Hi. So first off, could you just clarify between Q1 and Q2, specially the Q2 guidance. I was assuming there will be some spillovers as far as orders that you are going to fulfill in Q1 into Q2. And based on your commentary, it seems like that that could be more gallium than indium phosphide. So I am just trying to dissect here how much softness are you seeing in indium phosphide, if my first part of my commentary is correct?

Well, Hamed, there is some carryover. But the bigger question for us isn't how much carried over, it's what you accumulative weight of the rest of the customers in the quarter in the new orders. And as Morris said, we are seeing softness for some of the silicon photonics because of the data center and that's why we have taken a maybe more conservative viewpoint, as well as the some softness continuing in the raw materials business.

So is this softness that you are seeing, more because your customers have too much inventory in their hand? Because you are sold literally at the beginning stages of the product cycle. So what's leading to softness?

Well, I believe that we have shipped them for al six quarters now. It was not a beginning of the cycle. We supported our indium phosphide growth in 2017 for sere and even second half of 2016. But I think it is just that, there are speculations. One is that we heard data center may be, I guess, the inventory or whatnot. And then the other is that maybe the 400G transition. We are hearing our customers developing the new 400G product. But is that slowing down the 100G implementation? That's difficult for us to tell. But we just know that they told us they have inventory. They have to rebalance their inventory for the second quarter.

Okay. And then as far as just Q2 having more gallium in there, how comfortable are you with the shift in product mix providing a gross margin stability that's giving you the EPS guidance?

I feel we are comfortable, indium phosphide is not going to go down. It's just the PON market is still good. But we really have never had a quarter where both data center and the PON are both strong. So for most of 2017, the PON market was weak, but the data center was strong. In Q1 of 2018, the PON market was strong and the data center was a little bit down. And our high-end LEDs also have good gross margin and even our, although it's a smaller contribution, germanium has good gross margin. Our pBN crucible company has good gross margins. And our high-end gallium refining company has pretty good gross margins also. So in the course of the last couple years, the company sometimes has been a little bit choppy but the company has improved its cost structure, its yields and its capacity utilization and the product mix. So all of those are converging to give us reasonable confidence about gross margins. And of course, it's the hardest thing for us to predict accurately internally because there are so many variables. But I think our confidence is growing.

All right. Last question. Do you think this issue here, joint venture is a one quarter event? And does that really rely on gallium pricing continue to go up? Or is it okay at current prices?

Yes. This joint venture issue, I think although the gallium price has recovered, but as you know that gallium price historically has not reached a level to make it very, very profitable as well as the prolonged loss of the joint venture is creating problems in the organization. So it really needs our attention and hopefully there we can resolve it and obviously the higher price would help but perhaps it is not. We are seeing gallium price, I think, is fluctuating between $110. It is now up to $180 and recently it is coming back. But I think it just needs attention before we can feel comfortable that it will become a good growth joint venture again.

Okay. Thank you.

Thanks Hamed. Next question please.

There are no further questions at this time. This does conclude today's question-and-answer session. I would now like to turn the call back over to Dr. Morris Young for any further remarks.

Thank you for participating in our conference call. We will be participating in the 15th Annual Craig-Hallum Institutional Investor Conference on Wednesday, May 30 in Minneapolis. We look forward to seeing many of you there. As always, feel free to contact me, Gary Fischer or Leslie Green directly if you would like to meet with us. We look forward to speaking with you in the near future.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.